The BoC could spark a long-term reversal for USD/CAD

With markets heavily geared towards a BoC rate hike on Wednesday, could this provide the beginning of a big USD/CAD sell-off?

Cnadian dollar
Source: Bloomberg

This week sees the Bank of Canada (BoC) step up to the plate, in what is widely expected to herald the first Canadian rate rise in almost seven years. Interestingly, this widespread expectation of a rate July hike has been something of a sudden phenomenon, for it was just a month ago that Bloomberg priced the likeliness of a July hike at just 5%. Given that we now see that figure at 93%, it has been quite a month for the BoC. In fact, last month saw market expectation of a 2017 rate hike at just 30%, which highlights the significant shift we have seen. That shift in expectations and (potentially) actions will have an impact on the Canadian dollar.

Much of the reasoning behind this shift in expectations comes from the commentary being provided by BoC members. Senior Deputy Governor Carolyn Wilkins started the shift back on 12 June, citing the need to review ‘whether all of the considerable monetary policy stimulus presently in place is still required’ considering ‘pretty impressive’ first quarter (Q1) growth. Since then we have seen the core retail sales number punch to the second highest level in two years, exports rise to a record high of $48.7 billion, and an employment change number massively overshooting estimates with 45,000 vs 11,000 expected.

The one area that could undermine this story comes from inflation, which now lies at 0.1% on both consumer price index (CPI) and core CPI readings. However, Governor Stephen Poloz has largely refuted those fears, claiming that the bank must act before they actually see inflation rise to target, speculating at a potential two-year lag between policy and the impact.

Despite Bloomberg currently pricing a 93.1% chance that we will see rates rise on Wednesday, Goldman Sachs have gone against the grain, in calling for the first rate rise in October rather than this week. The view is that the lack of market reaction to a gradually more hawkish tone necessitated something more drastic in terms of language. Thus while a rate rise is around the corner, the almost non-existent inflation should prove enough to make the bank hold off. Considering how heavily weighted the market is in favour of a rate rise, the decision not to act could see a significant move against the dollar. However, on the flipside, the technicals are beginning to point towards a more long-lasting move in favour of the loonie which, if followed up by the BoC, could bring another strong move lower for USD/CAD.

The weekly chart highlights two crucial factors. Firstly, we saw a huge bull market in USD/CAD since 2010, which means there is a significant amount of ground to make up. A downturn for USD/CAD would by no means be trading out of ordinary historical prices. Secondly, the break below $1.2968 last week provided us with the first lower low in over a year. Coming off the back of an inability to reach or top the $1.4690 mark, there is reason to believe we are moving into a more bearish phase. Looking at the slope of the early 2016 sell-off, compared with the subsequent gains, it is clear that we are looking like we could be moving into a long-term downtrend, where a hawkish BoC could bring about another sharp move lower like that seen in Q1 2016. Looking at this chart, any gains brought about in the eventuality that the BoC opt not to hike would be seen as a likely precursor to a major sell-off in the forthcoming months. As such, the selling seen over recent months has provided us with a position where we would need to see a break back up through $1.3794 to look bullish once more.

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